May 26, 2015

Post-Bankruptcy Income and After Acquired Property – Beware the Pitfalls!

Bankrupts who use post-bankruptcy income to purchase non-exempt assets during their Bankruptcy have been held to receive after acquired property, which will vest in their Trustee and will be available for their creditors.

For most ordinary employees, income is paid directly by their employer into a nominated bank account. There it remains until it is used to meet living expenses and the like, with the residual either left to accumulate or used to invest in alternative classes of assets (ASX Listed Shares; Property; etc). A Bankrupt, however, is no ordinary employee. They are subject to and must be cognisant of, the provisions of the Bankruptcy Act 1966 (“the Act”), particularly with respect to income and after acquired property. Specifically:

  • Division 4B of Part 4 of the Act – Income (Assessment and Contributions);
  • Division 4 of Part 4 of the Act – Vesting of Property and After-Acquired Property (Section 58 of the Act); and
  • Division 3 of Part 6 of the Act – Divisible Property (Section 116(1) of the Act) and Non Divisible Property (Section 116(2) of the Act).

According to statistics published by the Australian Financial Security Authority (“AFSA”), 6,453 Bankrupts paid cumulative income contributions amounting to $48,243,827 to their estate in the 2013-14 financial year (at an average of $7,476 per estate). Of the 18,592 Bankruptcies filed in Australia in 2013-14, the majority of Bankrupts earn an income that is below the requisite threshold and are therefore not required to make compulsory income contributions to their estate. Considering this and the rehabilitative intent of the Act, what (if any) restriction is placed on a Bankrupt’s utilisation of post-bankruptcy income that is assessable and:

Falls wholly below the requisite threshold for compulsory income contributions; or
Is the residual available to the Bankrupt after payment of assessed compulsory contributions?

In Re Gillies; Ex parte Official Trustee in Bankruptcy FCA 289; (1993) 42 FCR 571, (“Re Gillies”) (in the context of considering the effect (at the time) of significant changes to the Act relating to after-acquired property) French J left the door ajar (somewhat) stating:
“I am inclined to the view that assets purchased by a Bankrupt with after-acquired income will, if not within any of the excluded categories in s 116(2), constitute property divisible among the creditors and vest in the trustee. In my opinion, however, no final decision should be given on this point which is still rather hypothetical.”

The issue fell for determination in Rodway v White WASC 201; 233 FLR 262, (“Rodway”) which considered the case of a Bankrupt who, during his Bankruptcy, purchased shares with residual post-bankruptcy income (after contribution to his Estate).
Heenan J, concluded that the conversion of income into a “distinctly different form of property”, namely shares, did result in the acquisition of after acquired property divisible among creditors and which vested in the (Bankruptcy) Trustee unless one of the categories excluded by Section 116(2) of the Act applied. Adopting the observations of French J in Re Gillies, Heenan J stated.

“The incongruity arises from the difference in character assumed to exist between income and property…income, take wages or salary for example, once received will probably be in the form of cash or credit in a bank or similar account. The accumulating cash on hand, and the accumulating balance in the bank or other account will each be a form of property of the Bankrupt from the moment it is paid or received. There is no suggestion that the proceeds of income, whether it be cash or credits in bank accounts, as originally received or accumulated will constitute “after acquired property” within the meaning of s 116. This is probably due to the effect of Div 4B and the idea that after-acquired property does not include income at least in the form in which it was earned.”

Notwithstanding the perceived determinative nature of the Rodway decision, the Court in Di Cioccio v Official Trustee in Bankruptcy FCA 782 & FCAFC 30 (“Di Cioccio”) was called upon to consider whether the Act was incongruent or conflicting on account of the application of post-bankruptcy income to the after acquired property provisions.  Pagone J (considering circumstances almost identical to Rodway), at first instance, declined to depart from the judgement in Rodway and Re Gilles that were not, in his view, “plainly or clearly wrong”: “It cannot be said that the construction adopted in Rodway…or the observation expressed in Re Gillies, is “clearly” or “plainly wrong” and ought not to be followed.”
In rejecting an appeal from the Bankrupt’s first instance defeat, HJ’s Edmonds, Gordon and Beach of the Full Federal Court bench added:

“ss 58 and 116 are concerned with property, not with the character of property as income or capital… Div 4B of Pt VI defines what is income…These provisions do not address what is, or what is not, the property of the Bankrupt divisible amongst the Bankrupt’s creditors.”

Their Honours specifically rejected the allegation of incongruence and conflict, citing the operation of discretionary powers in Section 134 of the Act as a “safety valve” that ought to be sensibly and fairly applied by Trustees. In addition, they cited the ability to apply post-bankruptcy income towards the purchase of tools of trade and other exempt assets that are expressly excluded as being divisible pursuant to Section 116(2) of the Act.

The decisions in Rodway and Di Cioccio, appear, somewhat harsh and inconsistent with the underlying rehabilitative intent of the Act, given that but for the acquisition of a class of asset other than the accumulation of cash at bank/cash on hand, non-assessable and/or contributable post-bankruptcy income would never attract the interest of the Bankrupt’s Trustee or his/her creditors. The decisions represent a strict interpretation of Sections 58 and 116 and 4B of Division 4B of Part 4 of the Act. Sections 58 and 116 do not delineate between the acquisition of shares with post-bankruptcy income on one hand, and the Bankrupt becoming beneficially entitled under a will or winning the lottery during their Bankruptcy on the other. The retention of post-bankruptcy income that is non assessable/contributable, in its purest form (in most cases, held in a bank account) will preserve its original character and expose it to assessment as income and not property, unless it is used to purchase a class of asset, which would enliven Sections 58 and 116 of the Act.

SV Partners have extensive experience and knowledge in all aspects of Personal Insolvency administration. If you or your clients require personal insolvency advice, please contact one of our advisors on 1800 246 801.

Article Author :Fabian Micheletto
Associate Director
03 9669 1100
[email protected]

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